IMF sees strong global growth

Little progress made on current account imbalances

WASHINGTON (MarketWatch) -- The global economy is on track for another couple of years of solid growth despite high energy prices and the risks stemming from large global imbalances, the International Monetary Fund said Wednesday in its World Economic Outlook.

The fund repeated its admonition that the largest economies in the world must begin to seriously address imbalances in demand, investment and savings before a global financial crisis erupts, throwing the global economy into recession.

It will take more than just a revaluation of the Chinese yuan, IMF chief economist Raghuram Rajan said Wednesday. "I think the U.S. should do more" to encourage national savings, including balancing the federal budget by 2010, he said.

"By no means am I asking for depreciation of the dollar," he told reporters. "What is important is to allow them to do what they do -- which is to remove rigidities in areas where those rigidities exist so that exchange rates can support the adjustment," he said.

But he acknowledged that "the dollar will have to depreciate over the medium-term to facilitate adjustments. That's simple economics."

Forecast

The global economy is projected to grow 4.9% in 2006 and 4.7% in 2007, close to the 5.3% reached in 2004 and the 4.8% growth of 2005, the IMF said.

The updated forecast is 0.6% higher for 2006 and 0.3% higher for 2007 than the forecast published in September. The improvement came primarily from stronger expected growth in China and India.

Most regions of the planet should benefit, the IMF said. Emerging market economies are expected to grow 6.9% in 2006 and 6.6% next year, while the advanced economies are expected to grow 3% this year and 2.8% next year. Among developing economies, only Latin America is expected to lag behind the global average.

The United States and China continue to be the main engines of growth, but the economy is improving in both Western Europe and Japan as well, the IMF said.

Time to act

The risks are largely to the downside, the IMF said. The main challenge remains the large imbalances in the current accounts of the United States, China, emerging Asia and the oil-exporting nations.

The time is ripe for action, the IMF said. But it said the same thing in September.

Only small progress has been made in reducing the imbalances.

Without a coordinated policy response, "there is a clear risk of a disruptive adjustment and a global recession," the IMF said.

"The principal challenge for global policymakers is to take advantage of the unusually favorable conjuncture to address these vulnerabilities," the IMF said. The solution calls for a weaker dollar and a stronger yuan, combined with lower consumption in the United States and more consumption in China and other countries with high savings rates.

The adjustment could be orderly or it could be catastrophic. But it will happen.

Rebalancing of demand and currency reform are both needed, the IMF said. "There is not a choice between one or the other."

"There may be a temptation to put this issue on the back burner," the IMF said. However, "the longer the adjustment is delayed, the larger these exchange rate adjustments will ultimately need to be, and the greater the risk of overshooting," the report said.

Thus far, only limited progress has been made on the needed adjustments. The U.S. decreased its fiscal deficit, but only temporarily. The Bush administration's plan to cut the deficit in half was termed "unambitious" and unlikely to boot. National savings remain too low. Americans continue to import too much.

In response, U.S. Treasury Secretary Timothy Adams said the U.S. is doing its part. He said any attempt to aggressively balance the budget would imperil global growth, because none of the high-saving nations have taken the steps needed to boost domestic demand. See full story.

China took a baby step toward exchange rate flexibility, and has moved toward more domestic consumption, the IMF said. The hypothetical foreign exchange flexibility "needs to be used more aggressively to allow the renminbi [or yuan] to respond to market pressures and appreciate," the IMF said.

Structural reforms in China, Europe and Japan are needed to boost domestic consumption, the fund said.

Inflation, oil

The IMF found little to quibble with about monetary policy, with global inflation largely contained. In a chapter released last week, the fund's economists said globalization would not always act as a disinflationary force. See full story.

High energy prices represent another main risk to the global economy. The forecast assumes crude oil prices will average $61.25 in 2006 and $63 in 2007. See full story.

The oil market remains vulnerable to shocks and to geopolitical risks. The impact of high prices has thus far been remarkably benign, but there is a chance that producers and consumers have not yet fully accepted that higher prices are here to stay.

Thus far, high energy prices have had little impact on core inflation or on inflation expectations. There's a chance that a linkage to core prices has only been delayed.

United States

In the United States, "the overall risks to the outlook are slanted to the downside," the fund said. With a current account deficit of 6.4% of gross domestic product, the U.S. is "vulnerable to a swing in investor sentiment that could put downward pressure on the dollar and see a spike in long-run interest rates."

"The future course of the housing market is a key uncertainty for the U.S. economy," the fund said. "A weaker housing market could trigger a more abrupt withdrawal of consumer demand than anticipated."

Europe

"The recovery in Europe appears to be strengthening," the fund said. "Looking forward, the expansion will continue to depend on strong global demand."

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